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Novum Alpha - Daily Analysis 21 September 2021 (10-Minute Read)

A wonderful Wednesday to you as concern over the potential fallout from China's Evergrande Group spills over into the global markets.

 

In brief (TL:DR)

 
  • U.S. stocks were hammered at the open on Monday, with the Dow Jones Industrial Average (-1.78%), S&P 500 (-1.70%) and tech-centric Nasdaq Composite (-2.19%) all sharply lower on heightened concerns over a potential debt default by China's Evergrande Group. 
  • Asian stocks continued a selloff on Tuesday amid concern about China’s crackdown on the real-estate sector and the debt crisis at developer China Evergrande Group.
  • Benchmark U.S. 10-year Treasury yields rose one basis point to 1.32% (yields rise when bond prices fall).
  • The dollar held gains.
  • Oil pared a slump with October 2021 contracts for WTI Crude Oil (Nymex) (+0.87%) at US$70.90 as the demand outlook remains uncertain with the Chinese economy.  
  • Gold held onto gains with December 2021 contracts for Gold (Comex) (+0.15%) at US$1,766.50.
  • Bitcoin (-9.91%) fell to US$42,581 with inflows continuing to race against outflows and as the malaise from the Evergrande Group crisis spreads into all risk assets (inflows suggest that traders are looking to sell Bitcoin in expectation of lower prices). 

 

In today's issue...

 
  1. How much longer will Beijing let Evergrande flounder?
  2. It’s Called “Common Prosperity” in China, what’s it called in the U.S.?
  3. Coinbase Abandons Lending Product

 

Market Overview

 
In times of heightened uncertainty, clear communication is crucial, but unfortunately, there's only been stony silence from China, as the world's most indebted real estate developer is staring down the abyss, with a crucial test this week of whether it can meet its debt obligations. 
 
Global investors are jittery as markets priced in the risk of a messy default by China's second-largest real estate developer, the privately-held Evergrande Group, even as Chinese officials have formed a task force to examine the embattled property giant. 
 
Although the odds are good that Beijing won't allow Evergrande Group to collapse under the weight of its own debt, it could come down to the wire as the deadline for paying down interest looms this week. 
 
In Asia, markets were a mixed bag, with Tokyo's Nikkei 225 (-1.97%) down while Sydney’s ASX 200 (+0.19%) and Hong Kong's Hang Seng (+0.01%) managed to stem losses on signs of equities being oversold despite the concerns over Evergrande Group. Seoul was closed for a holiday.
 

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1. How much longer will Beijing let Evergrande flounder?

 
  • Global investors are pricing in a messy collapse of China's Evergrande Group 
  • Chinese officials have already formed a task force to investigate the real estate developer, and a bailout should not be ruled out as a matter of course 
 
First, they came for my afterschool education companies, but I did not speak out, because I was not a tutor.
 
Then they came for my video games, but I did not speak out, because I was not a gamer.
 
Then they came for my real estate, and everyone was too busy looking for shelter to speak out for me.
 
As is often the case with so many other crises, global investors are growing increasingly concerned over the potential fallout from the default of a property developer in the world’s second largest economy that’s growing flakier by the minute.
 
Investors are worried that a US$300 billion collapse of China’s second-largest real estate developer Evergrande Group (-3.07%) could trigger a wave of subsequent defaults and derail the global economic recovery.
 
Volatility in global markets and the VIX, an indicator also known as the “fear gauge” in the U.S. is at its highest level since May last year, when the pandemic was battering assets.
 
From the Russian debt default to the Asian Financial Crisis, there is no shortage of examples of flaky emerging markets hoovering up investment monies globally, only to see those monies evaporate just as quickly as they were gathered, and this time is no different. 
 
While most asset bubbles inflate and burst under their own weight, the deepening crisis for the Evergrande Group is a result of Beijing’s restrictions on the property market, which is inflicting pain on property owners, investors and shareholders alike.
 
But unlike Tencent (-0.97%) or Alibaba (-2.05%), allowing the Evergrande Group to collapse will have far-reaching implications for the Chinese economy.
 
With over US$300 billion in obligations to creditors, 778 projects underway in 223 Chinese cities, can Beijing really afford for Evergrande Group to implode on itself?
 
The immediate stakes are relatively low – US$129 million of interest payments that are due on its bonds this month and around US$850 million due over the remainder of this year.
 
With the People’s Bank of China already pouring some US$29.38 billion into the banking system to shore up lending, there’s more than an outside chance that Evergrande Group will benefit from at least some of that liquidity.
 
Beijing wields considerable influence over the banking sector that is almost entirely state-owned and can issue an order at any time to bail Evergrande Group out, but some analysts are convinced that the Chinese government is intent on extracting the most amount of pain and making an example of Evergrande to serve as a warning to other real estate developers.
 
China’s so-called “three red lines” laid down last year aim to reduce debt levels in the heavily leveraged real estate sector and rein in chronic oversupply of residential property, but it’s also clear that Beijing can’t afford to go too far.
 
Unlike afterschool education and video games, China’s property sector makes up a whopping 29% of GDP and the annihilation of Evergrande Group would impair the entire industry, setting back a post-pandemic recovery, even as economic growth in the Middle Kingdom shows signs of slowing.
 

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2. It's Called "Common Prosperity" in China, what's it called in the U.S.?

 
  • The U.S. Federal Reserve is promoting an "inclusive" economy but providing few details as to what that means 
  • Possibility that the Fed intends to continue to remain engaged in the economy until such time that inequality is lower, and not necessarily on he basis of employment numbers alone 
 
Not so long ago, at the height of the Cold War, “socialism” was a dirty word in these United States, and would almost certainly attract derision, suspicion and an almost inevitable investigation.
 
Since then though, concerns that the capitalist system has provided for the few, at the expense of the many, has seen more people around the world challenge the existing world order and question whether the system is truly providing for the common good.
 
In China, that shift has been perceptible, painful and public, but in the U.S., the shift has been far more subtle, with the U.S. Federal Reserve’s vision of an “inclusive” economy.
 
Fed officials have publicly opined that they want to use monetary policy as a tool to promote an “inclusive” economy, with few details describing what such an economy might look like.
 
Median estimates in a recent Bloomberg survey reveal that most economists expect interest rate hikes won’t happen until 2023, when U.S. unemployment, and specifically African-American unemployment would have slipped back to numbers before the pandemic struck.
 
As the Fed gears up to start paring down its asset-buying program launched at the onset of the pandemic in 2020, investors are closely watching what happens next in terms of monetary policy.
 
A low unemployment rate is likely insufficient for the Fed to declare “mission accomplished” with officials now likely to want to see low-income and marginalized communities benefiting from the strong U.S. economy as well, something that is only likely to happen at the tail end of a long economic expansion.
 
As of last month, U.S. national unemployment was at 5.2% and African-American unemployment was a staggering 8.8%, but both are expected to come down rapidly this year as the economy recovers.
 
The bigger question will be whether policymakers view the pre-pandemic labor conditions as the best possible outcome or whether monetary policy can be used to aspire for a higher level of inclusivity, in which case the Fed may continue to be engaged in the economy in a meaningful way.
 

 

3. Coinbase Abandons Lending Product

 
  • Cryptocurrency exchange Coinbase Global abandons its cryptocurrency lending product 
  • Buckling to regulatory pressure Coinbase Global may serve as a warning to other fintech innovators to walk in the shadows as opposed to cooperating with regulators 
 
“I fought the law and the law won.”
 
– “I Fought the Law” by Sonny Curtis and the Crickets, off the album “In Style with the Crickets” © 1958 Sonny Curtis
 
U.S.-listed cryptocurrency exchange Coinbase Global (-3.53%) has dropped plans to launch a cryptocurrency lending product after bowing to pressure from the U.S. Securities and Exchange Commission, which threatened to sue the former if it went ahead.
 
The product in question, called “Lend” is not a new concept.
 
Unregulated cryptocurrency exchanges have been offering depositors as much as 7% on dollar-based stablecoin deposits for some time now and Coinbase Global was simply following a prevalent trend in the industry.
 
In a statement late last Friday, Coinbase Global said it had made a “difficult decision” to shelve its plans to offer the Lend product.
 
While Coinbase Global CEO Brian Armstrong had lashed out publicly at the SEC, arguing that the Lend product did not constitute a security, he ultimately had to backdown to regulatory pressure.
 
The move comes as regulators globally are looking to exercise greater oversight over cryptocurrency exchanges, regardless of jurisdiction.
 
Binance, the world’s largest cryptocurrency exchange by traded volume, has come under increased scrutiny by U.S. regulators, the latest of which has been an investigation into allegations of insider trading at the exchange.
 
Coinbase Global had first floated its Lend product in June, and was set to offer an initial 4% annual yield for holders of its stablecoin the USD Coin.
 
Exchanges gain doubly by offering such products because deposits can then be re-lent to other cryptocurrency traders who take leverage at high multiples of such interest rates or used to provide liquidity on their exchanges.
 
But the SEC’s threat to classify the Lend product as a security becomes somewhat problematic when viewed in the context that it operates similar to a bank deposit.
 
By the SEC’s definition of a security, current U.S. bank accounts, which are overseen by the U.S. Comptroller of the Currency, would also fall within the purview of the SEC, which would be a clear jurisdiction issue.
 
The SEC’s action actually muddies the waters for cryptocurrency companies, especially those who may have at least considered submitting themselves to more enhanced and visible regulation.
 
Given how volatile the digital asset markets already are, the move by the SEC to muddy the definition of what constitutes a “security” is actually a retrograde step and may force stakeholders to think twice about cooperating with regulators in the conduct of their business.
 
 

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Sep 21, 2021

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